For Trump's Auto Tariff Threats, Credibility Is the Name of the Game

In a decision that will have global implications, the United States will decide within the next few months whether it should place tariffs or quotas on auto imports.

The widespread implementation of such tariffs is not a given. Washington hopes to use the threat of the fees to seal concessions from major trading partners in which the auto sector makes up a significant chunk of the U.S. trade deficit.

Mexico and Canada have already secured tariff exemptions as a part of the USMCA and are unlikely to be targeted unless their auto exports exceed quotas they've already agreed to.

Japan and South Korea are positioned to avoid the pain of tariffs because they have agreed to voluntary export restrictions (or quotas) or reached deals as a part of free trade talks.

As the United States puts pressure on the European Union to break down barriers — including those in the agricultural sector — in upcoming free trade talks, German auto exports will face a higher risk of U.S. tariffs.

You cannot have national security without economic security. That has been a rallying cry for President Donald Trump since he moved into the White House in 2017. Trade has been a particular area of administration focus, and with that has come scrutiny of the buying and selling of automobiles and parts. For the past three months, Stratfor has examined what would happen to the global auto market if the United States moved forward with the administration's proposed tariffs on imports of vehicles and parts. It appears as if the White House is close to a decision on whether it can claim legal justification to impose those levies.

On Nov. 13 the administration held internal discussions with representatives of various government agencies over a draft report on the Commerce Department's investigation into whether auto imports could pose a threat to national security by weakening the U.S. economy. Such a finding would allow the president to impose tariffs under Section 232 of the of the Trade Expansion Act of 1962 without having to submit his decision for congressional approval. By asserting its ability to enact auto tariffs, the administration would gain a potent tool in its push to negotiate and revise trade agreements. In its dealings with countries that rely on the U.S. auto market, the Trump White House has used the threat of tariffs to extract trade concessions. But for that threat to remain credible, Trump must have the power to do so unilaterally — otherwise the pretense for tariffs will crumble. Now that a decision on the legal reasoning underpinning the strategy is imminent, so is the possible implementation of tariffs against certain countries. It is worth checking to see whether the chances that they can avoid those fees have improved.

Spoiler alert: They may not have.

The Big Picture

The U.S. assault on global trade could soon enter its next phase if the White House claims the power to increase tariffs on the auto sector. The fees — which could be as much as 25 percent — would represent the largest trade move for the White House since slapping tariffs on China. A series of Stratfor analyses over the past three months has weighed the effects of U.S. tariffs on the global auto market. And now, the White House is discussing a report that could move those tariffs from threat to action.

What Have We Learned?

On the campaign trail, Trump consistently lamented the decline of the U.S. manufacturing sector and promised voters that he would strengthen it. He also said the widening U.S. trade deficit was the result of unfair treatment by its trading partners, who were simply not buying enough American-made industrial products. And, he reasoned, increased competition imposed by unequal trade hurts segments of the population, increasing the chances of unrest among those citizens — who formed the core of his support in 2016 — and thus raising the risk to national security.

This was the argument that the White House laid out when it applied Section 232 tariffs to steel and aluminum imports. Applying the same logic to the automotive sector — which accounted for roughly 20 percent of the U.S. trade deficit in 2017 — would almost certainly result in the same conclusion. But for the Trump administration, whether that argument holds water isn't necessarily the point. The White House needs a legal justification for tariffs, and national security, which is the purview of the executive branch, offers the best path to that justification.

But to what end?

During the renegotiation of the North American Free Trade Agreement, a twofold U.S. strategy became evident. First, the United States used the threat of auto tariffs against Canada and Mexico to obtain concessions in the final United States-Mexico-Canada Agreement (as the revamped NAFTA was dubbed). It used that threat both on issues related to exports — such as its push for greater access for U.S. producers to Canada's dairy sector — and on the structure of the pact, such as the introduction of a sunset-type clause into the final deal. But the threat was used for much more than just leverage. The United States also got Mexico and Canada to agree to tariff-free quotas on the auto sector, and both agreed to a higher tariff if their exports exceeded a certain level (2.6 million cars per year, for example). Essentially, the United States used the threat to implement tariffs and quotas to not only restrict the import of vehicles in real terms, but also to incentivize an increase of domestic manufacturing.

In short, the administration's goal has been to put into place certain barriers on trade in the auto sector and to use the threat to break down other obstacles. Ultimately, the United States wants to tread carefully in actually imposing tariffs to their fullest extent to limit the backlash that could follow. And while it worked on Mexico and Canada, it may not work on other countries.

As demonstrated by the other trade measures it has taken, such as the steel and aluminum tariffs and moves against China, the threat of retaliation will not stop the White House.

The Trump administration had little room to maneuver on the issue of binding caps on auto-related imports from its neighbors. The quotas in the final draft will not immediately affect exports; in fact, the Trump administration knew that binding caps could end up harming U.S. workers. As analyst Reggie Thompson noted in Stratfor's examination of the North American auto sector, over the 25 years of NAFTA, the three countries' auto industries had become deeply integrated. That meant that restricting imports would either drive up the costs for U.S. auto assembly plants that sourced parts from Mexico or Canada or reduce demand for U.S.-made parts being used in final assembly in Mexico or Canada. That made binding quotas a no-go for Trump.

There are no comparable limits holding the White House back from imposing restrictions on auto imports from beyond North America. Its decisions on quotas could bring retaliatory measures such as tariffs, but nothing that would directly affect the U.S. auto industry. And as demonstrated by the other trade measures it has taken, such as the steel and aluminum tariffs and moves against China, the threat of retaliation will not stop the White House. The Trump administration has argued that running a trade deficit with another country gives the United States the upper hand in a trade war.

Use It or Lose It?

Over the next year, the United States and several trading partners — including the European Union and Japan — will engage in negotiations, while the United States tries to achieve its dual goals of increasing its trade barriers and reducing those imposed by others. High on the list for the European Union and Japan, meanwhile, will be the prevention of higher tariffs on their vehicle exports.

U.S. trade rules will block the United States from formally entering negotiations with either over a potential free trade agreement until Jan. 14, 2019. And even under the most aggressive timetable, those talks could not be expected to produce any agreements until 2020. During both sets of talks, the White House would like to be able to threaten to impose higher auto tariffs in an effort to extract concessions over non-tariff areas such as harmonizing safety standards and regulations (a significant non-tariff barrier in many industries). That means that the threat must remain in place throughout the discussions to allow the United States to maintain pressure and keep both parties at the table.

But maintaining the threat that long could prove to be a problem. Under Section 232, Trump's warnings have a built-in expiration date of sorts. The Commerce Department must submit the final findings of its auto investigation to the White House by Feb. 17, and once that happens Trump will have just 90 days to accept or reject them. If he believes that the talks with the European Union or Japan are on the right track, he could certainly issue waivers exempting them from the tariffs, just as he did initially for Canada and Mexico on the steel and aluminum tariffs.

This route would leave Trump with the option of deciding whether to continue extending the exemption as negotiations drag on. Neither the European Union nor Japan would be comfortable negotiating with that vulnerability hanging over their heads. After all, if talks started to languish, Trump could repeat his actions from mid-2018 when the NAFTA renegotiations stalled: He refused to renew the steel and aluminum tariff waivers granted to Mexico and Canada, allowing them to expire.

This said, it does remain possible that domestic opposition to auto tariffs — from either inside Trump's administration or in Congress — could prevent their imposition. But because tariffs on the auto industry outside North America would not decimate supply chains in the same way that they would have against Mexico and Canada, there is less incentive for Congress to pass legislation restricting Trump. In addition, the president could conclude that the results of the U.S. midterm elections, in which Republicans from states with extensive auto manufacturing operations such as Wisconsin, Pennsylvania, Michigan and even Ohio performed poorly, could mean that he was not aggressive enough in fulfilling the trade promises that fueled his wins there in 2016. That could perhaps embolden him to follow through with more tariffs ahead of the 2020 presidential election.

One limiting factor on that strategy, however, could be whether retaliatory actions become a strong enough re-election risk that Trump backs away from the tariff path. The trade war with China, for instance, has stung U.S. farmers and exporters, dinging his popularity among them. This could push Trump to suggest imposing binding quotas on auto imports, which would not have retaliatory measures attached, instead of tariffs.

Because tariffs on the auto industry outside North America would not decimate supply chains in the same way that they would have against Mexico and Canada, there is less incentive for Congress to pass legislation restricting Trump.

The European Union: A Struggle Ahead

As the European Union pursues free trade talks with the United States, avoiding the threat of auto tariffs will prove difficult for Brussels. As preliminary discussions between U.S. and EU negotiators continue, it has become increasingly clear that the two sides cannot agree even on what to include in the talks. The United States clearly has put the opening of the protected EU agricultural sector on the agenda. Trump signaled this as a priority with a tweet earlier this week, slamming the tariffs and non-tariff barriers the union has placed on wine.

As my colleague Adriano Bosoni wrote, putting the agricultural sector in play hits at the European Union's heart by pitting auto-export powerhouse Germany against France and its tradition of agricultural protectionism. The United States has also criticized the slow process that the union follows before agreeing to talk about certain issues. But as a matter of process, EU member states have yet to empower the European Commission to negotiate a free trade agreement with the United States. The body hopes to receive a mandate to do so in early 2019, but during the approval process, EU member states will be able to define the parameters of any talks. If France blocks allowing agriculture to be included in negotiations, for example, it could sound the death knell for talks from the U.S. perspective. Moreover, elections for the European Parliament will take place in May, followed by the appointment of a new European Commission in October, adding even more difficulty to the effort to wrap up trade talks sooner rather than later. If free trade talks with the United States fail, the European Union still may be able to avoid auto tariffs, but this would likely hinge on the willingness of Germany and the bloc to accept quotas instead of tariffs.

Japan: Well-Positioned, but Not Entirely Confident

Japan has also reluctantly entered free trade talks with the United States, but unlike the European Union, there are few internal limits preventing Tokyo from moving quickly on a trade deal. After all, Japan has already negotiated one free trade agreement with the United States, the Trans-Pacific Partnership (TPP). Although Trump pulled the United States out of the TPP shortly after taking office, many of the most contentious concessions that the United States will ask Japan to make, such as breaking down non-tariff barriers on the automotive sector and easing some protections in Japan's agricultural market, had already been covered by TPP negotiators. Those concessions will, at the least, give Tokyo and Washington a starting point in their talks.

Japan's auto sector, as Stratfor Asia-Pacific analyst Evan Rees noted, is poised to weather a tariff storm. Unlike their German counterparts, Japanese automakers have been moving manufacturing operations to the United States and elsewhere in North America for decades. In fact, Honda, Nissan and Toyota each produce more than half of their cars destined for the U.S. market in North America, and thus they would not be as deeply affected by import tariffs. The continued expansion of North American production by Japanese automakers also would give Japan an incentive to agree to quotas near (or slightly below) current levels, knowing that over time, those quotas would not be binding. Japan is no stranger to voluntarily restricting exports of automobiles (and other products) to the United States to avoid tariffs. It was a routine part of doing business in the 1970s and 1980s. However, such measures would impose costs on a sector vital to Japan, and Tokyo would find agreeing to them particularly risky going into 2019, when a consumption tax hike could dampen economic growth.

South Korea: Exposed but Somewhat Buffered

South Korea is the other large source of cars for the U.S. market. Unlike Japan and the European Union, South Korea already has a trade deal with the United States, one that has been renegotiated under the Trump administration. This likely will give it a leg up as far as avoiding tariffs because there are few issues for Seoul and the United States to discuss beyond the auto sector. The Trump administration will likely push for quotas, and South Korea, whose automakers have yet to develop the same assembly capacity in North America as Japan, will almost certainly accept some level of quotas to avoid tariffs. Seoul accepted quotas in previous talks over steel. Moreover, it does not have the same leverage as the European Union, for example, to place retaliatory tariffs on imports from the United States.

If the Commerce Department finds that auto exports do indeed pose a threat to U.S. national security, the rest of the world — with the exception of the United Kingdom, which will open talks with the United States on a post-Brexit trade deal — will struggle to escape U.S. tariffs on finished cars. Depending on what the investigation concludes, those tariffs could also apply to auto parts, a significant export product for China and Southeast Asian countries. None is a major vehicle trading partner, and with the exception of China, none is on the U.S. priority list for broader talks. This will increase the risk that they, like many other countries beyond the main U.S. auto trading partners, will be caught in the crossfire.

Nevertheless, with the Commerce Department's investigative process almost complete, and formal U.S. trade talks with Japan and with the European Union set to start in roughly two months, the threat that auto tariffs will be implemented is as real now as ever.

Matthew Bey is an energy and technology analyst for Stratfor, where he monitors a variety of global issues and trends. In particular, he focuses on energy and political developments in OPEC member states and the consequences of such developments on oil producers and the international oil market. Mr. Bey's work includes studies on the global impact of rising U.S. energy production, the recent fall in oil prices, Russia's political influence on Europe through energy, and long-term trends in energy and manufacturing.